A few quick notes:
- Economic bubbles are pretty simple: Something is a bubble when the price a group of investors is willing to pay for it exceeds its intrinsic value. If hype exceeds reality, a bubble forms. But you can’t squeeze money from hype and when people try and fail the bubble bursts — think housing bubble, Dot-Com bubble #1 (2000), etc.
- Bitcoin has no intrinsic value: If I pay $500 for an ear of corn, I’m a sucker, but at least I’m a sucker who’s got a snack handy. But for Bitcoin, that’s a tricky question, because really Bitcoin doesn’t have any intrinsic value. Dollar bills also don’t have intrinsic value. Gold coins can be turned into circuits. Grain can be eaten. Giant rocks with holes in them can be sat on. Bitcoin is fundamentally worthless without its network. By design, it’s only worth what the people buying Bitcoin, and accepting Bitcoin as payment, think it’s worth. It is a currency driven solely by the free market.
- Bitcoin is literally just lines of code: At root, Bitcoin is an experiment in digital currency. Here’s a very broad, non-technical overview of how it works. The Bitcoins, the stuff of value, are “mined” by doing complex computations to create strong encryption. The encryption is the selling point; it’s so strong that you can’t forge Bitcoin. The other important aspect is the blockchain, essentially a giant ledger that everyone who mines, buys, or sells Bitcoin has on their computer. The blockchain is basically the entire history of Bitcoin trade, and everybody, and we mean everybody’s, blockchain has to match. That’s another layer against forgery. There’s more to it if you want to delve, but that’s the most basic overview.
- Nothing like Bitcoin has ever existed before: It’s not often discussed, but Bitcoin is inherently political; it’s designed to create a money system separate from governments and other sources of authority, which is why originally it was so popular with the right-wing and libertarian side of the internet and why that side of things still has such a strong emotional investment in it. To this point, any currency has been centralized, that is, issued by a government. Bitcoin is “issued” by a network of computers doing the math. A currency has had some sort of physical marker, like dollars, although that’s increasingly more a matter of theory than reality. Consider that your paycheck is directly deposited into your bank account, and you probably spend it by swiping a card or using Venmo instead of shuffling around pieces of paper or discs of metal. Bitcoin is all digital.
- That makes Bitcoin tricky, economically: Depending on how you value software or your political beliefs, Bitcoin was a bubble from the start. Practically speaking, however, Bitcoin is probably always going to have some form of value. If nothing else, the libertarian subculture that spawned it, and cryptocurrency’s sketchy role in anonymous online transactions, means there’s always going to be Bitcoin or something like it around. So the question becomes, can Bitcoin become an everyday currency, not just an asset traded by tech billionaires and that guy calling himself John Galt on Reddit? Will you use Bitcoin to buy beer at the corner store? Will your paycheck ever arrive in Bitcoin? Probably not, and… therein lies the problem.
- Bitcoin has one big flaw that will keep it from “going mainstream”: Let’s harken back to your digital paycheck. It sounds quite a bit like Bitcoin, but there’s one very important difference. Let’s say a hacker steals your debit card and cleans out your account, something you learn about and immediately report to the bank. Thanks to the Federal Deposit Insurance Corporation, you are most likely getting your money back. If thieves blow the doors off the vault and leave with the physical stacks of paper your bank has on hand to represent your paycheck, the government will send law enforcement to find the thieves, and you are most likely getting your money back. If hackers steal your Bitcoin from a website that originally was set up to sell cards from the popular nerd game Magic The Gathering and stumbled into being a vast financial exchange, you probably won’t even get an apology, forget restitution.
- This means Bitcoin is always going to be volatile: Bitcoin is built to be a true free market currency, and the free market is inherently a roller coaster, affected by a host of factors. The current spike in value, most economic experts agree, is because Bitcoin is so hot right now. Everyone’s talking about it, that makes people interested in buying it (including institutional investors with millions to spend) and that’s driving up the price. In other words, people are invested financially in Bitcoin, but their emotional investment is pretty much nil. Most Bitcoin investors don’t want to turn it into a currency to rival the dollar, they’re just jumping on the bandwagon to unload their coins for a quick buck in the future. So what happens when demand dies down as people move on to the new fad? Probably a drop. How far and how steep is anybody’s guess. It could be a crash, a gentle leveling off, or somewhere between the two, but it’ll happen. Bitcoin is certainly interesting and shouldn’t be dismissed, but it’s also got an undeniable “pet rock” element.
- Invest accordingly: Like we said, Bitcoin has a few institutional limits, and you need to think of it within those limits. Never invest, or have more, in Bitcoin, than you’re willing to lose, and don’t be swept up by the hype or the politics. Bitcoin can be a lot of fun, and it’s a fascinating experiment, but don’t volunteer to be the guinea pig. If you don’t have Winklevoss money, you may not want to take a major risk. Of course, fortune favors the bold, so…